Liquid Funds- An Ideal Option for Short Term Funds

For years now, savings accounts have been the popular choice for those seeking to park their liquid cash. Considered a safe bet, they have not lost their shine amongst investors, despite their meager returns. Now here is an attractive alternative to park your short term funds. Liquid funds are an ideal option for that extra bit of money you have as, not only do they offer a better yield, they are easy to liquidate too. So how do liquid funds work and where is your money actually invested? Read on to understand more.

Investing in Liquid Funds

Liquid funds are debt mutual funds, which invest your money in short term money market instruments, such as certificate of deposits, commercial paper and treasury bills, all of which have maturities of less than a year. A recent study done by a leading credit agency, stated that in the last five years, the post-tax annualized returns of a liquid fund was around 5.78%, in comparison to savings account which yielded just around 2.5%.In the last one year alone, liquid funds have generated a return between 7 to 8%.The scheme aims to provide modest returns to investors, along with the availability of quick liquidity. Most funds could be redeemed in a day or two.

Key Features

A lock in of a maximum of three days to even a week or a month exists to protect against any procedural glitches.

No entry and exit load. An exit load is however applicable if the fund is redeemed before the lock in period.

Minimum investment ranging between Rs 1,000 to Rs. 5,000 depending on the fund.

Tax aspect: Returns are tax free in the investors’ hands, if the dividend option is taken. There is a dividend distribution tax of 28.33 % on liquid funds and 14.16 % on liquid plus funds, for individual investors. Short term capital gains (if sold within a year) and long term capital gains (if sold post a year) is applicable.

Who Should Invest in Liquid Funds?

Liquid Funds are open ended schemes and serve as an ideal option for investors with a short term investment horizon and a low risk appetite. So if you are wondering what to do with that surplus cash in your savings account, which you do not require in the near future ( say up to a year), liquid funds are definitely a good deal.

Returns from Liquid Funds

Liquid funds, offer returns that are more or less comparable to fixed deposits. Its historical returns have been around 7%. But what I like is that they provide investors with the liquidity of a savings account.

Risk Factor of Liquid Funds

Though the portfolio of liquid funds comprises of short –term deposits, government securities and money market instruments, they cannot be considered as totally risk free. This is because liquidity patterns and short term interest rates of the government change, sometimes on a daily basis, thereby making the fund susceptible. Such interest rate changes though have a low impact on the fund. Before investing do look into the reputation of the fund house and the past performance of the scheme over a longer period with appropriate benchmarks.

Bank Accounts versus Liquid Funds

Here is a quick comparison between bank accounts (fixed deposits and savings accounts) and liquid funds.